Our New York Magazine Article: “‘Alpha Wolves in the Henhouse’: California’s Multibillion-Dollar Private-Equity Boondoggle”

We hope you don’t mind the extra helping of CalPERS articles today. Although they are both about CalPERS’ private equity “new business model,” you’ll see that this piece looks at it from a much broader vantage than JJ Jelincic’s article. His piece, which I hope you’ll also read if you haven’t yet, makes detailed observations about staff’s efforts to justify the scheme. The New York Magazine article, by contrast, take a big picture perspective. It also made Google Alerts for “CalPERS,” so it should be giving CalPERS staff some well-deserved heartburn.

If you are so inclined, please comment at New York Magazine as well as here. I know some of you had problems when your tried commenting on earlier articles. I alerted my editor and he said the tech team was working on it, so we hope they’ve fixed the glitches. Thanks!

The $340 billion California Public Employees’ Retirement System, or CalPERS, has been laboring mightily recently to launch a “new private equity business model” — four new initiatives ostensibly designed to improve on the fund’s return — just as private equity reporters, in a departure from their usual form, have taken to ridiculing the nation’s biggest and once highly-esteemed public pension fund. Sam Sutton and Chris Witkowsky of PE Hub burst out laughing on a 2017 podcast. Dan Primack of Axios compared CalPERS’ private equity machinations to how “a toddler treats a Netflix queue.” The Wall Street Journal even trolled CalPERS over its ostensible trouble with understanding investment fees and presented the giant fund as in need of gee-whiz algos to do its basic bean counting.

But these reporters may have been missing the real story. Even months after presenting a supposedly final version of its new model, which has since been revised considerably, the giant fund has yet to offer a coherent justification of why it is making radical changes, particularly since most of the elements of this new scheme would further enrich already egregiously well-compensated private equity industry professionals. Giving more to investment middlemen is inconsistent with the principles of improving returns and with CalPERS’ long-standing efforts to minimize investment costs. Even the normally deferential Pensions & Investments devoted much of a lengthy story published last month to puzzling over the contradictions and inconsistencies of the plan.

In other words, this plan is so criminally incompetent that insiders are wondering about actual criminality. Former board member J.J. Jelincic, who was present at the private equity initiative’s inception, says:

In all my years of working with the system, I’ve never seen anything that makes my hair stand up on the back of my neck like this. Even though I can’t point to anything specific, my gut says someone will go to jail if this gets done. And my gut has a good track record.

The original plan, which was announced with great fanfare in May, was based around four “pillar” initiatives. One was to turn most and perhaps all of CalPERS current investment over to a “fund of funds” manager. The second was to commit more money to “emerging managers,” as in younger and smaller funds, even though this is the worst-performing of CalPERS’ current strategies. The third and fourth pillars had the same structure but different strategies. As originally described, CalPERS would commit roughly $5 billion each to two newly created private equity firms that would have CalPERS as their only client. Each would pursue a fad: “late-stage venture capital” and “Warren Buffett investing,” meaning ownership of investee companies for longer than the usual four to five years and a focus on the “core economy,” whatever that means.

If you don’t know the private equity industry, you are unlikely to detect defects that are obvious to incumbents. This plan would send CalPERS in the opposite direction of its peers in their own attempts to improve private equity returns, which involve building up their skills and bringing more of their private equity investing in-house to cut fees and reduce costs. CalPERS has estimated its annual private equity fees and costs at a mind-boggling 7 percent per year. Cutting that to 2 or 3 percent by relying on CalPERS’ own staff would add directly to returns. CalPERS can pay new hires market rates as long as it can substantiate the compensation level. Canadian pension funds are already well down this path and some American pension funds are following them.

But CalPERS is perversely determined to launch a “new business model” which has no realistic prospect of bettering returns, and worse, three of its four initiatives would almost certainly increase its costs. For instance, the two newly created funds would have CalPERS paying for start-up expenses on top of everything else, when first-time managers underperform established players. And two $5 billion commitments would reduce CalPERS’ diversification, another negative for expected returns.

*  * *

Why should shenanigans in provincial Sacramento matter? CalPERS’ conduct provides a peek into the tight, seldom-examined interrelationships between state and local government pension systems and private equity fund managers. And that includes more unsavory activity than the public is aware of, including criminal conduct. A former CalPERS CEO is now in federal prison serving a four-and-a-half-year sentence for bribery and fraud, and a former board member killed himself before his prosecution began. And CalPERS is far from alone. Alan Hevesi, the former comptroller of New York State and sole trustee for the state’s pension fund, went to jail, in part, for accepting bribes from a private equity firm. The former treasurer of Connecticut, Paul Silvester, landed in prison thanks to a bribery scandal involving a D.C.-based private equity firm, Carlyle.

The story continues here. Thanks again!

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30 comments

  1. flora

    Great post! Thanks for your continued reporting on CalPERS, PE, and pensions.

    ~
    adding: clicking the NYM story’s comments red button didn’t display the comments for this story for me.

    Here’s a tip for seeing the New York Magazine comments for
    Windows users running Firefox, and probably other browsers:

    Right-click on the red comments button and select “Open Link in New Tab”. When the new tab appears and finishes loading at top of your browser, open to see the comments for the story.

    Reply
    1. flora

      addendum: I see now that the comments do show up if you click the comments button, but I had to scroll down thru a lot of stuff to find them, at the very bottom of the scroll. The right-click method still works.

      Reply
      1. ChiGal in Carolina

        It is possible to make comments too but you have to give them a user name, your email, and create a password. Never did this before, but it’s for a good cause!

        Reply
  2. shinola

    The entire article is worth a read (if you’re not burned out on the whole CalPERS thing).

    After reading today’s earlier article & many of the previous CalPERS revelations posted here in NC, this just seems (to me anyway) like an obvious corruption encouraging/enabling scheme.

    Have conflict of interest & corruption become so commonplace that no one pays attention or cares anymore? Makes ya wonder…

    Reply
    1. flora

      I’m not burned out. The CalPERS intransigence means this is no simple mistake, no simple oversight, but a plan executed with full knowledge (or easily available knowledge – see NC) that the plan is a loser for CalPERS beneficiaries, an avoidable disaster. This level of… I don’t know the right word here…. corruption?…. intellectual capture?…. stupidity? This level of … takes a long time to expose and root out. CalPERS board probably thought NC would give up and stop by now. Reminds me of the tag line (edited) in the movie ‘Butch Cassidy and the Sundance Kid’: “who is that NC?”

      Reply
      1. none

        > This level of… I don’t know the right word here…. corruption?…. intellectual capture?…. stupidity?

        Ordinary criminality. Money attracts grifters like shit attracts flies.

        Reply
      2. ChiGal in Carolina

        Ha! And instead the “crazy blogger” is publishing in NYMag.

        Congrats Yves and time to break out the champagne!

        Reply
      3. Tom Bradford

        >This level of… I don’t know the right word here…. corruption?…. intellectual capture?…. stupidity?

        English has an excellent word – “cupidity”

        Reply
  3. grayslady

    Your article could easily be part of a mandatory primer on investment strategies and investment management. Each point was clear and appropriately illustrated by example. It reminds me of the HBS cases we used to see, with CalPERS being the “company”; plenty of room for student discussion and prognostications on this one.

    Reply
  4. taunger

    Great article incorporating multiple layers or negligence and misconduct. Does justice to your detailed calpers work and puts it in an important larger context. Thanks.

    Reply
  5. Matthew G. Saroff

    Again, who at CalPers is benefiting from this?

    It’s clearly corrupt, but I’d like to think that whoever is ultimately behind this is getting paid, and not doing it for free, because ……… markets!

    Reply
      1. none

        Terry Fancher seems to be related to the Fancher family of the famous LDS Mountain Meadows Massacre. I wonder if he is connected with Mitt Romney somehow.

        Reply
  6. The Rev Kev

    “so it should be giving CalPERS staff some well-deserved heartburn”. Oh I would suggest the burn is being felt in another region altogether. And Willie Brown got himself on the Board? I’m surprised that he didn’t try to get his arm-bracelet elected as well. Is that how Buenrostro came to get the job of CEO back then? Great article that. If I was in a high position with that mob, I would be keeping notes of what is happening from week to week and having each week officially notarized. That way when the proverbial stuff hits the oscillatory mechanism, you own part will be clear and should help both investigators as well as the teams of lawyers that will eventually show up. Just to be safe, I would have multiple copies in multiple locations. Just being a suspenders and braces man here.

    Reply
    1. Yves Smith Post author

      This was the best placement she could get. It’s guaranteed that the PR department shopped this to the LA Times, Sacramento Bee, Mercury News, SF Chronicle and was turned down.

      Circulation 23,000 v. 1.1-.1.5 million page view a month for Naked Capitalism and over 250,000 unique viewers a month.

      Reply
      1. Conrad

        Wow I never knew this place was so big! Well done to you and the team. And thanks for not going all monetization heavy on us.

        Reply
  7. David in Santa Cruz

    This NY Magazine piece is brilliantly reported and so well-written! However it begs the question: cui bono? I would be less concerned about the way that investment funds are being stealthily dealt-out to political players if CalPERS was actually well-funded, but CEO Frost has to be the only person in the world innumerate enough to think that the funding-level that she touts is anything other than complete nonsense.

    Follow the money…

    Reply
  8. Joey

    I’m only burnt out on CALpers because I live in Kentucky and our pension mismanagement is more egregious if lower dollar. That being said, my political transformation was completed by Taibbi’s similar reporting on Birmingham Alabama’s jp Morgan sewer refinancing (genesis- “patriot act”/ Abu Ghraib).
    So thanks NC, for sunshine in grimy corners.

    Reply
  9. Cathryn Mataga

    So if/when CALpers runs short, who ends up holding the bag? Do the pension recipients get cuts? Or does the state have to make up the difference?

    Reply
    1. Yves Smith Post author

      In California, government pensions are extremely well protected. CalPERS runs over 2000 funds on behalf of the state, municipalities, and other governmental bodies.

      The employers are responsible for the shortfalls, so for state employee pensions, it would be the State of California, and for the others, it would be the government body, like the city of Anaheim.

      Reply
  10. Katherine

    More cowbell, er, I mean CalPERS.

    I can’t get enough of these posts.

    Keep on doing what you do, its appreciated.

    Reply
  11. dbk

    Extremely impressive piece, congratulations well deserved.

    “This stands in contrast to other countries, like the Netherlands, where public pension fund board members are selected from public workers who must pass investment competency tests.”

    This would have described CalPERS ca. 2000, I reckon.

    The current situation seems bizarre and inexplicable, even factoring in the obvious conclusion that somebody (-ies) inside the agency must (also) be profiting from such poor investment strategies.

    Reply
  12. William Hunter Duncan

    Speaking truth about power is no easy thing in the seat of empire.

    Great work. Hopefully enough people get it before the whole system gets burned up, like America turned into a pot stew left on high and forgotten.

    Reply
  13. ALM

    Another round of letters to state officials is in order. BTW, the only California state official who responded to my written complaints about Marci Frost’s resume fraud is Senator Jerry Hill (or rather his staff) who refused to intervene on the grounds that it was none of their business. Very disappointing.

    Reply
  14. Susan the other

    Thanks Yves, this was really good. I went over to NYMag but didn’t comment there because my keyboard is too screwed up. This story is so amazing in an appalling way I’m surprised that these details don’t mobilize the pitchforks. Frankly I’m pretty surprised the state of CA hasn’t taken over CalPERS because that would be the best thing for now. The state itself in a partnership with the municipalities. These guys, from Marcie on down, have no business running a pension fund at all, clearly.

    Reply

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